In the past 24 months China real estate investors have been battling the effects of financial de-risking, which has restricted the availability of debt; the US-China trade war, which has lowered growth and hit exports; and the coronavirus, which brought the economy almost to a halt in February.

Covid-19, which emerged in the city of Wuhan, has had the most dramatic and immediate effect on the real estate market. Transactions, already at a halt for the Chinese New Year holiday at the end of January, have barely started up again. Shopping centers and hotels have been all but deserted by customers, while office workers all over the country have been working from home. As of March 10, more than 80,000 people had been infected and over 3,000 people had died from the virus.

There has been a range of intensity in the coronavirus effects. Hubei, the province where it started, was locked down, with people remaining in their homes and not traveling into or out of the region. Elsewhere, restrictions on movement have varied according to the seriousness of the outbreak.

The impact on the Chinese economy is forecast to be dramatic, but the extent of the damage is as yet unknown. Forecaster Oxford Economics has downgraded its prediction for China 2020 GDP growth to 4.8 percent, having predicted growth of 5.4 percent earlier this year. The 60 basis point downgrade is equivalent to around 600 billion yuan ($86 billion; €78 billion) of lost growth.

Tommy Wu, lead economist at Oxford Economics, says: “The return to economic normality in China has been very slow since the coronavirus outbreak. Economic activity came to a standstill in the first half of February due to the extended Chinese New Year holidays in most of the mainland’s provinces and cities, with transport restrictions implemented at local levels. This was then followed by slow work resumption in subsequent weeks.”

However, Oxford Economics is still predicting a “robust” recovery in the second and third quarters as China gets back to work.

The retail and hospitality sectors have been hardest hit, with shopping center footfall down as much as 90 percent and centers in the worst-affected areas closed. Hotel occupancy has fallen to single figures: global chain Marriott temporarily closed a quarter of its Chinese hotels.

The logistics sector has been hit by the manufacturing slowdown, but rising e-commerce – as people turn to online shopping and food delivery – has softened the blow. Anecdotal evidence suggests activity fell by 40-60 percent in most warehouses. Most office occupiers have staff working from home, but most offices have remained open outside of the quarantine zone.

David Kim, head of private funds at ARA Asset Management, which manages retail and office properties across China, says: “We have worked with tenants to give them rental respite for February and March and will continue to monitor the situation closely. The impacts will be felt for several months. Footfall is down 80-90 percent in malls but people are returning to work in offices. The government has already warned that people should not take advantage of this situation and just as we are trying to soften the blow for our tenants, it makes sense for banks to be lenient wherever possible.”

Investment activity falters

The investment market has largely stalled, especially regarding new sales. A few major asset sales that were in the pipeline have been shelved for the time being, while some deals that were near completion have been sealed. For example, in February, Singaporean sovereign wealth fund GIC announced the acquisition of Beijing’s LG Twin Towers from South Korean conglomerate LG Group for more than 8 billion yuan.

Stuart Crow, CEO, Asia-Pacific capital markets at broker JLL, says: “The commercial market has come to almost a complete halt [during February]. Buyers can’t make site visits so they can’t carry out due diligence and numerous sellers have put their sales on hold. There are a few sales going through, but a fraction of the usual volume.”

The first quarter of the year tends to be quiet in any case in China due to the Lunar New Year holiday, which took place this year from January 24-30. Real Capital Analytics data show a year-on-year fall in transactions of 69 percent in January and 58 percent in February. Meanwhile, residential sales volumes have started to creep up but are still well behind the seasonal average and many transactions are reported to be taking place online.

The lack of activity so far this year means there is little rental and pricing information available. However, rents were already coming under pressure in the office sector. For example, Cushman & Wakefield reports Grade A offices in Shanghai and Beijing having fallen 1 percent and 1.3 percent, respectively, over 2019 due to the slowing Chinese economy. Some office landlords, especially state-owned enterprises, have offered rental relief to tenants, but brokers expect the rental slowdown to continue, especially in markets with substantial supply and vacancy. For example, the second-tier office markets of Chongqing, Shenyang, Suzhou and Changsha all had vacancy rates above 30 percent at the end of 2019, according to Cushman & Wakefield data.

Opportunities on the horizon

While the US-China trade war has slowed the economy, the Chinese government’s financial de-risking program has been more important for real estate. In recent years regulators have cracked down on non-bank lending, which is deemed to present a risk to the economy. This has restricted financing for both Chinese companies and property developers, which in turn led to substantial asset sales in 2019.

JLL’s Crow says: “There have been substantial sales from Chinese firms in any case and we assume these will accelerate once the market comes back. Whether there will be many forced sales depends on how long this lasts. At the moment it seems China will be back on track in a couple of months, but the longer the market is offline, the more likely it is we’ll see distress.”

Real Capital Analytics data show overseas investment in China real estate rose 41 percent last year to $13.62 billion. Only one of the top 10 buyers of real estate in China last year was based in mainland China, while seven of the top 10 sellers were Chinese.

Henry Chin, head of Asia-Pacific and European research at CBRE, says: “Before the coronavirus there were a handful of Chinese developers with a more than 100 percent net-gearing-ratio with a significant amount of short-term 24-month loans. So, they were already exposed and are likely to face cashflow issues.”

The People’s Bank of China injected 1.7 trillion yuan into the economy on February 3-4 and it has established a 300 billion yuan fund, which will be lent to selected companies at a discounted rate of no more than 3.15 percent.

A range of initiatives at both the national and local level have been introduced to support business. However, funding will not get easier for developers, says Chin. “The Chinese government has reiterated that they will provide financial support for SMEs but not for property companies.”

CBRE estimates Asian private real estate funds have $51 billion of dry powder and that around $10 billion of that is allocated to China. “The appetite is there, once the travel ban is relaxed and people can get to and around China,” says Chin.

Kelvin Wong, principal and managing director at investment manager Pamfleet, says: “There may be opportunities to buy from domestic companies and state-owned enterprises which put properties on the market in order to release cash.”

Additionally, Chinese authorities have announced a range of measures to open the financial sector to foreign institutions. Measures include permitting the formation of wholly owned subsidiaries and expediting approvals.

The combination of these measures, ongoing attempts to reduce financial instability, and domestic companies’ need to shore up their balance sheets suggests more opportunities for foreign investment in China real estate in the future.

Logistics reaps the benefits

Another current trend set to be boosted by the coronavirus outbreak is the growth of the logistics sector and its popularity with investors.

“Retail has taken a hit and a lot of shopping has moved to e-commerce, which is great news for logistics, especially last-mile logistics,” says CBRE’s Chin. CBRE predicts that underutilized retail space could be used for last-mile logistics, either providing pick-up points for online shoppers or adapting space for smaller logistics facilities.

Most logistics investors in China are underwriting their investments with the expectation that consumption will drive the market, rather than exports, so the attractiveness of the sector ought to be undiminished. In March, ARA Asset Management announced the completion of its acquisition of a majority stake in logistics real estate specialist LOGOS, which has a China portfolio of approximately 10 million square feet.

The halt to China manufacturing in February gave rise to more speculation that substantial amounts of manufacturing will be moved from China to South-East Asian locations, such as Vietnam, which has already benefited from the US-China trade war.

Last year, exports from Vietnam to the US rose 35.6 percent as manufacturers moved production to avoid US tariffs. The trade war, however, did not start the trend. Chinese manufacturers were already moving lower-end manufacturing to Vietnam in order to take advantage of low staff costs.

Chin says: “Most manufacturing in China will stay where it is, as 60 percent of it is to serve the domestic markets, but we will see some move to South-East Asia and also ‘re-shoring’ to South Korea and Taiwan, for manufacturing where South-East Asia lacks the capabilities.”

ARA’s Kim adds: “China is almost 20 percent of world GDP and far more integrated with the world economy than in 2003. It can’t simply be sidelined and all the manufacturing moved to Vietnam.”

Workplace priorities shift

In the office sector, Chin predicts that “the coronavirus will boost a number of long-term trends, such as agile working, decentralization and a landlord focus on the wellness aspect of sustainability.”

With most of China being forced into agile working in February, occupiers are expected to demand more flexibility from their landlords, which could boost both domestic and international co-working brands. The market for flexible workspace in China has been highly competitive, with several failures.

“This large-scale trial may encourage companies to be more willing to accelerate the adoption of flexible and homeworking polices in future,” says Chin.

Kim notes that “having our property management team in-house has helped us react more quickly and effectively” to the coronavirus outbreak. More investment managers may be encouraged to do the same, while the industry as a whole is expected to require more professional property management and a particular focus on hygiene and more frequent and rigorous sanitization of the office environment.

The focus on hygiene dovetails with a growing interest in health and wellness among occupiers and developers. Previously, this had been focused on air quality, which is a problem in many Chinese cities and is becoming a differentiator in promoting new office buildings. Now the focus is set to become broader.

Real estate investment managers have not only had to support their tenants, but also their investors.

Pamfleet’s Wong says his firm has been conducting stress tests on the portfolio, including parameters such as “a slowdown in leasing demand, downward rental pressure, extended downtime and vacancies and increases in construction cost and project delays” and communicating these to investors. Investment managers say concerns over the coronavirus – both its effect on China and the impact on the global economy – have led to a hiatus in fundraising.

Kim says: “Fundraising for China has come to a standstill, but I believe it will come back.”

JLL’s Crow adds: “I don’t think there are any investors who have lost confidence in China as a result; the positive dynamics of the market remain intact.”

With the rate of infection in China slowing down rapidly and the approach of warmer weather less conducive to viruses, most people in China real estate remain optimistic the market will bounce back. Now, the larger question seems to be what effect covid-19 will have on the rest of the world.


Developing trends

Opening up: China is liberalizing its financial markets but not drowning real estate in cheap debt, which bodes well for foreign investors

Going the extra mile: There will be more demand for last-mile and city-fringe logistics as e-commerce continues to boom

Staying healthy: Wellness is set to be a key investment theme in China’s office sector

Moving up: Chinese manufacturing will continue to move overseas, opening up opportunities for a change to higher use

Better management: Property and asset management will become increasingly important for both landlords and tenants

Limbering up: Agile working will be more in demand